Colorado’s a state that every marijuana investor should be watching because its maturing recreational market offers insight into what may happen in other states that legalize cannabis. So far, Colorado’s recreational marijuana market has been a success. Since recreational marijuana became available in 2014, marijuana sales have grown from $996 million in 2015 to $1.25 billion in 2016 to $1.49 billion in 2017. Can demand push Colorado’s marijuana sales even higher in 2018?
The marijuana movement
Momentum to end marijuana prohibition has picked up significant momentum over the past 20 years and that momentum has increased as more states have passed laws creating recreational marijuana markets. So far, 30 states have medical marijuana laws on the books and eight of those states have OK’d recreational marijuana, too.
It’s likely that more states will follow suit, especially given shifting attitudes among Americans. Since Gallup began asking Americans about their opinions on marijuana in 1969, there’s never been a time when more Americans have favored legalizing it.
The research company’s 2017 survey shows that 64% of the country believes that marijuana use should be legal, including 72% of Democrats and 51% of Republicans. Democrats have supported legalizing marijuana since 2010, but it’s only recently that Republican support has picked up. Only 28% of Republicans were OK with legal weed in 2010 and only 35% were in favor of legalization as recently as three years ago.
Improving support among conservatives to legalize marijuana may suggest that worries over stricter enforcement of federal laws prohibiting marijuana by the Trump administration may be overblown. If so, it wouldn’t be surprising if more red states start paying attention to what’s going on in Colorado, the first state to legalize and tax recreational use.
Colorado’s marijuana market grows up
Colorado’s recreational marijuana market has been a big success by many measures. In terms of sales and tax revenue, it’s been a particularly good experience.
The state’s marijuana sales have increased from $699 million in 2014 to nearly 1.5 billion last year, and according to GreenWave Advisors, sales could hit $1.64 billion in 2018. State tax revenue from marijuana taxes, licenses, and fees added $247.4 million to Colorado’s budget in 2017, up from $193.6 million in 2016, and $135 million in 2015.
Undeniably, legalization has shifted a significant share of marijuana sales from the black market to dispensaries. However, GreenWave’s 2018 forecast does suggest marijuana investors and industry participants might want to start tempering their optimism. If Colorado’s market achieves GreenWave’s estimate this year, it would represent just 10% year-over-year growth, which isn’t nearly as impressive as we’ve witnessed so far. Sales grew 19% year over year last year alone.
Colorado’s decelerating growth rate may be explained by the fact that its market has matured and is now serving most residents who are interested in consuming marijuana. It could also be because marijuana wholesale prices are falling. The state’s marijuana producers have rushed to add capacity to meet demand and that may have resulted in too much marijuana production. In November, The Economist reported that marijuana prices per pound have declined from $2,000 in early 2015 to about $1,300. That trend has continued this winter. According to Cannabis Benchmarks, Colorado spot prices per pound fell $210 last week to $1,131.
Should investors be worried?
Colorado’s slowing growth and falling wholesale prices may lead to consolidation as smaller operators with higher operating costs sell-out or close shop. If that happens, then investors will need to become more selective when it comes to picking which marijuana stocks to buy or businesses to invest in.
A thinning of the herd in Colorado could ultimately be good news for the strongest players. However, there’s still plenty of obstacles that make investing in U.S. marijuana companies risky. For example, marijuana’s still illegal at the federal level, so marijuana businesses have limited access to banking services, they can’t build scale by operating across state lines, and they’re forced to pay inflated tax bills because they can’t deduct many common business expenses.
Those headwinds make it hard for me to recommend U.S. marijuana stocks, so investors might want to stay focused on Canadian marijuana stocks, at least until winners and losers in individual state markets become clear or Congress ends prohibition. Canada’s medical marijuana market is well established and has national support. Importantly, its recreational marijuana market is expected to open for business this year, and if that goes off without a hitch, marijuana revenue in Canada could double. If so, Canopy Growth and Aphria Inc. are likely to be the biggest beneficiaries. Each is enjoying rapid revenue growth already and profitability is improving, too. Canopy Growth is forecasting that its investments in preparation for the opening of Canada’s recreational market put it in a position to start consistently generating earnings soon and Aphria’s already posted multiple quarters of increasing net income.
Admittedly, neither is a cheap stock based on traditional valuation measures, such as price to sales, but if the recreational market pans out as people expect, there’s a good chance these companies can grow into their valuation over time.